INITIAL CLAIMS: AUTOPILOT ENGAGED

Claims Improvement Begets Further Claims Improvement ....

The headline initial claims number fell 9k last week to 358k (falling 15k after the upward revision to the prior week). Rolling claims fell by 11k WoW to 366k this week. On a non-seasonally-adjusted basis, reported claims fell 24k WoW to 398k.

Claims remain on autopilot, for now. While some of the strength here is the byproduct of a seasonal distortion that will roll from tailwind to headwind around the end of February, the underlying trends are still very positive. Our hypothesis has been that falling claims become self-reinforcing once they break through the 375-400k level because that is the rate below which the unemployment rate can decline sustainably. This, in turn, fosters greater confidence among hiring managers and consumers, which begets further reductions in claims. The treadmill has become virtuous. This remains a key theme supporting our bullish stance on the large-cap financials. We expect this trend to continue over the intermediate term. To be clear, we're not suggesting that claims must fall week-in and week-out going forward. That would be ridiculous. Rather, we're suggesting that the general trend lower in the rolling claims series is likely to persist going forward.

The table below shows the stock performance of each Financial subsector over four durations.

Joshua Steiner, CFA

Allison Kaptur

Robert Belsky

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02/09/12 09:19 AM EST

MPEL 4Q11 CONF CALL NOTES

Strong quarter but the sellside continues to compare the lower of MPEL's actual and "hold adj" EBITDA to the higher of their own nominal and "hold adj" estimate.

"The meaningful ramp up in our mass market operations over the past year, which is evident in the sustained improvements in margins and group-wide profitability, is particularly pleasing...we are well positioned to take advantage of the shift of the gaming epicenter to Cotai, particularly in the mass market segments, driving long term profitability and shareholder value."

Continue to focus on better yielding their offerings to drive better margins

They are optimistic about GGR growth in Macau, in particular, mass market growth

Took share in the mass table segment despite new supply in the market

$200MM 4Q EBITDA hold adjusted at 2.85%

Remained disciplined in junket commissions

CoD - hold adjusted EBITDA contribution was 1/3 of total in 4Q11 down from 50% in 4Q10

1Q12 Guidance:

D&A: $90-95MM

Net interest expense: $25-30MM

Corp expense: $18-20MM

Q&A

They have improved their mass productivity per table materially

More of their junkets have moved to a revenue share program from a RC program

They continue to be optimistic about 2012, which is off to a good start

Reduction of tables at Altira/increase at CoD?

They may shift some more tables to CoD from Altira

They are putting in a program to expand their VIP operations at CoD in the coming months by adding 3 new junkets

As a policy, they do not intend to compete on pricing for junkets

Hold adjusted margins were 21%

Think that Chinese economic growth will continued to be measured. However, they have seen no slowdown in the consumer discretionary sector. They project 15-20% GGR growth with GDP growth of 8%.

Cash balance and debt situation and funds needed for MSC

$1.2BN of cash & equivalents, excluded long term restricted cash

They are working through their financing for MSC - bank loans

$1.9BN total project cost, equity contribution pro-rata between them and their minority partner

Table transition from Altira to CoD?

The table productivity at Altira is a little lower than at CoD. So they are moving more junkets to a revenue share model which attracts more 'larger' and well-capitalized junkets.

Receivables: $307MM; 1/3 related to premium direct and the rest related to junket. The provision for the quarter was $10MM - in-line with the rest of the year

What are the milestones for MSC?

Their process is a little different. It's really about restarting construction vs. getting brand new approvals

Their next announcement would be a restart of construction. They need to 'refresh' several aspects of their initial agreement before they can commence construction.

They are not looking to do an equity raise for the project

HIGHLIGHTS FROM THE RELEASE

$1,008MM of net revenues and $232MM of Adjusted EBITDA

CoD: net revenue of $696MM and $187MM EBITDA

Altira:net revenue of $268MM and $53MM EBITDA

"We have continued to execute on our premium strategy, both in the rolling chip and mass market gaming segments, as well as in our world-class entertainment and other non-gaming amenities. We believe our premium mass market focus at City of Dreams represents one of our key competitive advantages, giving us an ability to capture and leverage a loyal and more profitable customer base."

"Our design plans in relation to Studio City are effectively complete and we are undergoing the necessary Government processes to obtain the required approvals to commence construction. At the same time, we are working through our financing plans in relation to this project which will potentially include a bank loan and other debt financing."

"We continue to build out our Mocha Clubs network, opening Mocha Macau Tower in September 2011 and Mocha Golden Dragon in January 2012. With 300 gaming machines, the Golden Dragon facility has quickly become one of the best performing clubs in our Mocha portfolio."

4Q Capex: $56MM, of which $14MM was related to design and preliminary costs associated with MSC

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02/09/12 09:14 AM EST

AG SETTLEMENT: BAD FOR CREDIT CARDS, GREAT FOR SERVICING BANKS

A Year in the Making ...

The long-rumored servicer settlement details are out at last, with a final announcement expected later today. We've dug in to the details, and it looks like a strong win for the banks. Of the $26B total value (per the WSJ), only about $5B is in the form of cash payment. The balance is from principal write-downs and economic benefit of refinancing. That's a sweetheart deal, especially considering that the principal write-downs can involve mortgages that the servicers don't even own. For details, see below.

- Of the $21-22 billion, $17 billion will apply to mortgage-backed securities investors, having no impact on the banks.

- The remaining $3-5 billion will be principal forgiveness and underwater refinancing

- Principal Write-Downs: Banks must effect $17B of principal write-downs for current borrowers.

Hedgeye: Banks are using the best kind of money to pay for these principal write-downs: other people's money. Yes, this $17B will come out of the pocket of private label MBS investors. Haven't PLMBS investors suffered enough? In all seriousness, are there any accusations of wrongdoing against PLMBS investors? Why are they bearing the cost? If the argument is to help the broader housing market by helping underwater borrowers, this is a drop in the bucket. Estimates of the total underwater balance of US borrowers are in the $700B - $750B range. $17B barely touches that.

- Payment to borrowers: According to the WSJ and FT, borrowers will receive payments totaling $4.2 - $5.0B. The WSJ reports that $1.5B of that will go to borrowers who were foreclosed between September 2008 and last December.

Hedgeye: This makes little sense to us. If a borrower wasn't wrongfully foreclosed on, why do they get any monetary settlement? And if a borrower was wrongfully removed from their home (as happened in certain cases), then a $1,500 payment hardly constitutes justice. What's more, the time frame is odd. Did the banks change their practices at the beginning of 2012?

Refinancing: Banks must provide $3B worth of benefit to borrowers in the form of refinancing.

Hedgeye: This is once again other people's money, except to the extent that banks are refinancing loans that they own.

Liability Waivers: Banks are freed from further liability from the AGs or regulators around foreclosures. However, they don't gain liability waivers around MERS (NY AG Scheiderman's suit will proceed) or around securitization (Schneiderman again, along with the FHFA).

Hedgeye: That's a pretty good deal on foreclosure wrongs - some states have serious penalties for wrongful foreclosures, and the servicers escape the threat of all of that. Waivers on other elements would be a real gift.

Implications of Rising Foreclosures - Bad News For Cards

We wrote extensively on the negative implications of a servicer settlement for the credit card operators back on 7/11/11. But to recap our thoughts we offer the following summary. Clearing the legal morass around foreclosures will cause them to re-accelerate. The chart below shows the swift drop-off in foreclosure filings when the robosigning scandal broke in October 2010. While reformed practices may slow the timeline somewhat compared to the pre-scandal time period, and increase in the pace of foreclosures from current levels is very likely. This has several implications:

1) More pressure on home prices: More low-level transactions in the distressed market pulls the home price indicators lower. Extremely low comps can also pressure non-distressed transactions.

2) More bankruptcies: As we showed in a prior research report, foreclosures are highly correlated with bankruptcies. Although the causality isn't always from foreclosures to bankruptcies, it often is: a bankruptcy filing can serve as a last-ditch effort to save a home. Increasing bankruptcy filings is a negative for the credit card issuers. We believe that part of the very low credit costs at the card names for the last five quarters is due to the artificial suppression of foreclosures. Because bankruptcies flow straight to charge-offs without spending time in delinquent status, the increase in credit costs could hit very quickly. This would be a negative for the pure-play card names (COF, DFS, AXP) and would slightly offset the benefit for the moneycenters.

Joshua Steiner, CFA

Allison Kaptur

Robert Belsky

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Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

CHART OF THE DAY: Bad Macro

Bad Macro

“The macro is so bad everywhere. In America, our political leadership is doing nothing to help us get out of the current situation. Worldwide, Europe is just in a state of financial collapse. I think we are in plenty of trouble and have to watch ourselves closely.”

-Julian Robertson on CNBC, September 13th, 2011

While Julian Robertson is retired from managing other people’s money, prior to his retirement he established probably the best long term record of any money manager with a reported annual return of north of 30% from 1980 to 1998. More impressive to me has been his ability to mentor, train, and seed successful money managers after retiring from the business himself.

I’ve had the pleasure of meeting Mr. Robertson a number of times. The most notable for me was while I was attending Columbia Business School and took a class called, “The Analyst’s Edge”, which was taught by John Griffin, founder of Blue Ridge Capital and the former President of Tiger Management. This class offered me, and my fellow students, a crash course in analyzing companies from the practitioner’s perspective. In lieu of a final exam, our final grade was based on pitching a stock to Julian Robertson in the Tiger Management boardroom.

Not only was the situation itself intimidating, but the company I had spent the semester researching was Ace Aviation, more commonly known as Air Canada. As background, in 1999, the year that Tiger Management dramatically underperformed the SP500 and eventually shut its doors, U.S. Airways was purportedly Tiger’s largest equity holding and a key reason for the underperformance. So, yes, I was pitching an airline to Mr. Robertson, even though it was the industry that had burned him a few short years before.

Shockingly, despite my somewhat sweaty palms, the pitch actually went relatively well. Mr. Robertson was very thoughtful in his questions as it related to my thesis, which was primarily based on a sum-of-the-parts analysis, and seemed very intrigued by the idea. Now, of course, he may have just been trying to be polite, but I think the better answer is that a key reason he was, and remains, one of the world’s great investors, is his ability to have an open mind and change opinion. In effect, he showed incredible mental flexibility.

I highlighted the quote above to flag the simple fact that Mr. Robertson went on CNBC to emphasize how negative the macro was at the literal 2011 bottom of the stock market. In fact, since September 13th, 2011 the SP500 is up more than 15% and the Euro Stoxx 100 is up more than 23%. On an annualized basis, those moves would equate to some of the best annual equity index returns in the last hundred years. So, was Julian Robertson wrong based on his dour September 13th, 2011 macro outlook? Well, that ultimately depends how his portfolio was positioned for the last four months. My guess is that Mr. Robertson and his protégées managed the environment quite effectively and kept their feet moving.

Interestingly, on September 13th our CEO Keith McCullough (he is on the road today in Boston) wrote the Early Look and while we shared an eerily similar fundamental view as Mr. Robertson, Keith wrote the following that morning:

“Great short sellers in this game have one thing in common – they know when to cover . . . I’ve written 2 intraday notes in Q3 of 2011 titled “Short Covering Opportunity” (one on August 8th and one yesterday). Yesterday’s call to cover shorts generated as much questioning and feedback as any time I think I have ever made a call to cover shorts since the thralls of early 2009. This is an important sentiment indicator.”

In hindsight, making the aggressive short covering call on September 12th of last year was the correct call. Some might call it luck, but for us it was born out of our global macro process. Now, arguably, we probably should have gotten even more aggressively long. As always though, the first step in the stock market business is to not lose money.

Coming into 2012 we were as bullish as we’ve been in awhile. One of our key 2012 macro themes was that the rate of global growth slowing would bottom. In our macro models, marginal rates of change in growth are critical, but as critical is monetary policy, which influences growth. On January 25th of 2012, the FOMC released the policy statement post their December meeting, with the key line being:

“In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

In the Chart of the Day, we’ve attached an analysis that looks at inflation versus the price to earnings ratio of U.S. equities from 1978 to 2008. The r squared between CPI, the proxy for inflation, and P/E is very highly correlated at 0.76. As the curve demonstrates, inflation is bad for equities. That’s not a guess, that’s a fact based on the data and underscores our shift in outlook post the FOMC statement in January. Some call this mental flexibility, for us it is process. So far, by the way, we’ve been wrong on U.S. equities in the shorter term duration. That said, fighting the Fed worked in 2011.

While I am on the topic of Julian Robertson this morning, I would like to give him credit for more than being one of the best money managers of our time and an incredible mentor of young money managers. I would also like to acknowledge his leadership in philanthropy. As Albert Einstein said:

“The value of a man resides in what he gives and not in what he is capable of receiving.”

Thank You!

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